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Executive Summary

LKM (the Indonesian acronym of Micro Finance Institution) plays a veryimportant role in giving contribution to economic development in ad-vanced as well as developing countries. In the 1990s, LKM undoubtedlyassumed a more prominent role in giving contribution to economic de-velopment, particularly in the attempt to alleviate poverty.

Finance institutions in Indonesia were put to a severe test during theperiod of monetary economic crisis in 1997/1998. Dozens of generalbanks had to be closed down by Bank Indonesia because of bank-ruptcy and could no longer be saved. The general bank bankruptcyled to the bankruptcy of several bank customers, particularly me-dium and large business enterprises, which in turn made other banksalso become less healthy. Bank Mandiri is a form of solution result-ing from the merger of four unhealthy government banks, namelyBank Dagang Negara, Bank Exim, Bank Bumi Daya, and Bapindo.Conversely, in 1997, BPR (banks apecializing in the provision of creditfor people) began to flourish, because the target customers were themicro, small, and medium business sectors that were not much af-fected by the economic crisis.

Learning from the experience of micro finance institutions that provedto have endured during the economic crisis, a lot of general bankseventually joined in working the small and medium business sectorby forming a micro service unit. As a result, competition in the mi-cro finance market became tighter. Particularly, a number of BPRBKK (Regency Credit Providing Body) local enterprises failed in thecompetition and became unhealthy. Those BPR BKK local enterpriseswere generally faced with internal problems, such as weak humanresources, inadequate capital, inefficiency, and ineffective control. Itwas for this reason that shareholders became motivatived to mergeBPRs and BKKs in Central Java, starting with BPR BKK local enter-prises in Semarang regency. Merger of BPR BKK local enterpriseswas a historical event for micro finance industry in Central Java, be-cause the BPR BKK local enterprises comprised 350 BPRs (not in-cluding 160 BKKs) out of a total of around 600 BPRs in Central Java.Out of 9 BPR BKK local enterprises scattered within Semarang re-gency territory, one BPR was unhealthy, four healthy enough, and

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four healthy. Based on preliminary estimate, unhealthy BPR BKKlocal enterprises could be saved after merging and prevented frombankruptcy that might eventually lead to liquidation.

BPR BKK local enterprise of Ungaran as a micro finance institution,local government-owned corporation belonging to the governmentof Central Java province and Semarang regency with its role as a localbank bears the mission of capital and funding intermediacy in themicro, small and medium business sectors. To gain excellent com-petitive ability, it had to be brave in consolidating funds and distrib-uting credit to people together with general banks and other BPRs.To be able to compete, BPRs and BKKs first had to be large, healthyand strong. To realize this, merger provided an immediate solution.

The merger of BPR BKK Ungaran was expected to result in consoli-dated efforts between BPR BKK branches to extend their operationsand strengthen bank funding structure. The flow of fund from banksto the community was one of the means to activate the economy andcommunity empowerment. The BPR BKK merging process involvedinstitutional dynamics, service dynamics, employees' psychologicalburden and competition between shareholders in turning in theircapital.

This reality of merger is worth examining. Despite the large numberof researches already conducted on this subject, this merger of BPRBKK local enterprises was a unique case, because it was a rare occa-sion as far as large-scale merger of finance institutions was concerned.For this reason, the research problems were formulated as follows:(1) What motivations did BPR BKK Ungaran stakeholders have andwhat role did they play in doing the merger?, (2) How was the mergerdynamics of BPRs and BKKs as local banks striving to become healthybanks and play a role in the community economic empowermentscheme?, (3) How was the form and role of trust relations as financialand non-financial support of BPR BKK's performance?

The merger of BPR BKK local enterprises was of horizontal natureemployed as an external development strategy. Merger was not awaste of resources, but conversely, it was meant to improve the effi-ciency of resources (Jensen, 1984). Various economic and non-eco-nomic motivations underlying merger have been revealed in re-searches on different companies. Consolidation was one of the popu-

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lar motives for merger (Moin: 2003, Weston and Mitchel et all: 2004).Consolidation could be translated into more real motives (MahmudZ: 2009), among others to increase profit, economic scale, and to ex-tend market segments.

BPR merger had to be implemented based on the Official Decision ofBI Board of Directors no 32/51/Kep/Dir 14 May 1999 on merger, con-solidation, and acquisition. BPRs were not obliged to observe soundcompetition laws, as there was no need for concern about the possi-bility of monopoly being created because the micro finance marketwas highly competitive, and even giant general banks could be in-cluded in this segment.

The present study was designed to analyse the motivations underly-ing merger, increase in significance of the stakeholders' role duringand after the merging process in activating the economy and com-munity empowerment. The study also included analysis of the formand role of trust relations that could support BPR's performance fi-nancially as well as non-financially.

In the perspective of economic development or community empow-erment, BPR BKK local enterprises as local banks played an impor-tant role. The relations between BPR and its customers could beillustrated in the concept of trust relationship (Putman, 1993), whichbecame important, because local bank-customer relations were notonly of business but also of familial nature. Long-term relationshipbetween banks and customers could create positive values on bothparties, because such a relationship through repeated loans or long-term savings could reduce transactional costs (Sunarto, H: 2007).

Analysis of BPR BKK's level of health by means of CAMEL approachwould complement the present study, because CAMEL could be usedto measure the shareholders' role in turning in their capital and alsoto analyse asset quality. The new management duly formed could beused as materials for management analysis, while the profit gainedcould be used as materials for bank ROA and ROE analysis. Bankliquidity analysis was based on the liquid funds available to pay outwithdrawal of funds already received from the community and fundsthat were distributed to the community. The criteria of bank healthmeasurement determined by Bank Indonesia consisted of five com-ponents, namely capital adequacy, asset quality, management, earn-

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ing ability, sufficient liquidity, and sensitivity to market risk could beadded to the list.

To find out the impact of merger, financial data analysis was con-ducted based on time chronology and comparison. Chronologicalfinancial data was compared between three years before and four yearsafter the merger took place. In the comparative analysis, the dataduring the four-year period after the merger was compared to findout similarities and/or differences between BPRs and BKKs ofSemarang regency and those of Central Java province.

Based on the formulation of the three research problems and the re-search objectives, after conducting theoretical study, field study, andanalysis, the writer drew the following conclusions:

Stakeholders' Motivation and Role

Stakeholders' motivation and role in the merger of BPRs and BKKsfrom the whole Semarang regency into Ungaran BPR and BKK localenterprise were as follows:

The merging of BPR and BKK local enterprises in general and UngaranBPR and BKK local enterprise in particular, were motivated by theneed to save BPR and BKK local enterprises as a whole and particu-larly unsound BPR and BKK local enterprises. The unfavourable con-dition was caused by the low quality of human resources, inadequatecapital, inefficiency, and ineffective control. Merger was a means toimprove the condition of the banks and maintain their sustainability.This was evident from the fact that after the merger, BPR and BKKlocal enterprises depicted improved performance from various dimen-sions: business volume, capital adequacy, management and humanresources quality, and service extension. Generally speaking, themerging of BPR and BKK local enterprises has created consolidationthrough overhead cost reduction (less supervisory or managementpersonnel) by creating values for the stakeholders' interest.

All stakeholders played important roles according to their respectivecapacities. Starting from shareholders, Bank Indonesia, Board of Di-rectors, and Supervisory Board that were getting more effective, em-ployees, and customers, and improvements were even noted in goodbanking governance practices, particularly in the mechanism of thegeneral meeting of shareholders that was getting more professional.

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Merger involved several unavoidable processes that could not be de-tached from the dynamics in operation.

Prior to the merging process, in the constitution of BPR and BKKsfrom the whole Semarang regency, institutional dynamics had oc-curred, starting from a credit providing body pilot project called BKKbecoming BUMD (Local Government Owned Enterprise) BKK, andin 1992 became BUMD BPR BKK.

The process of BPRs and BKKs from the whole Semarang regencymerging into BPR BKK Ungaran went through several phases anddynamics, starting from merger initiative, continued with socializa-tion of the plan for merger, conducting cooperative study to banksset up through merger, announcement of merger, making the mergerdesign, submission of related documents to get approval from CentralBank of Indonesia, realization of merger, making changes in the bankstatute, appointment of new management team, making a new workplan, balance consolidation, and capital conversion. In the mergingprocess, the shareholders also agreed to maintain the status of BPRand BKK Ungaran, the product of merger, as a local enterprise corpo-ration as stipulated in Local Regulations no. 11/2008 with its headoffice situated in the local regency/municipality.

In the merging process, there was a common agreement among allBPR BKK Ungaran shareholders as expressed in the general meetingto provide additional capital for banks whose capital was less than8%, arrange the status of employees, and settle their rights and obli-gations.

Dynamics of Merger Process

BPR BKK merger process took a long time. The merging of 9 BPRBKK local enterprises from the whole Semarang regency, where 8BPR BKK local enterprises combined into BPR BKK Local EnterpriseUngaran Branch went through several phases and dynamics. Start-ing with preparation for merger, agreement reached by all BPR BKKUngaran shareholders in the general meeting to provide additionalcapital for banks whose capital was still below 8%, arrange the statusof employees, and settle their rights and obligations. The next phasewas socialization of the plan for merger, making a comparative studyto banks set up through merger, announcement of merger, making

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the merger design, submission of related documents to get approvalfrom Central Bank of Indonesia, realization of merger, making changesin the bank statute, appointment of a new management team, mak-ing a new work plan, balance consolidation, capital conversion, andin the merging process, the shareholders agreed to maintain the sta-tus of BPR BKK Ungaran, the product of merger, as a local enterprisecorporation as stipulated in Local Regulations no. 11/2008 with itshead office situated in the local regency/municipality.

A number of dynamics that occurred in the merger process included,among others, reluctance to do merger in the form of rejection ofmerger, postponement of merger, psychological impact onunaccomodated officials, dismissal of employees who committed fi-nancial deviations, improved performance, and bank development.A special dynamics that normally did not apply to other corporationswas related to share percentage distribution already arranged in localregulations, so that the government of Central Java province as ma-jority shareholders always attempted to meet the portion assigned tothem, i.e. 51% and regency government 49%. In the general meetingof shareholders, Central Java province government became the keydecision maker on placement of management team members and otherpolicies, because based on governmental hierarchy, provincialgovernment's position was higher than regency/municipal govern-ment, while from shareholding position, provincial government heldthe majority of shares. Another important event was Bank Jatengshare divestment.

In the process of BPR BKK from the whole regency into BPR BKKUngaran, several phenomena were noted, such as the impact of mergerand institutional dynamics, administrative and licensing dynamics,employee affair dynamics, psychological impact on unaccomodatedofficials, period of turmoil and employee dismissal, competition indepositing capital between provincial and regency/municipal govern-ment on the one land and BPR BKK Ungaran on the other.

Based on the above findings, it could be concluded that the BPR BKKUngaran merging process has brought positive impact that was evi-dent in improved performance, increased trust on the part of the com-munity because new management was available, and bank manage-ment transparency became more distinct so that the bank became

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better and healthier.

Impact of BPR BPKK Ungaran Merger

Post merger bank development was evident in improved performancebased on such indicators as bank assets, the amount of credit given,third party's funds and profit. In other words, after the merger, thebank was making more progress. All bank CAMEL elements wereimproving, which depicted healthier development. Or it could beconcluded that the combine of 9 BPR BKK local enterprises inSemarang regency which were not healthy enough before the mergerbecame healthy after the merger was realized. The results of com-parison between the health level of all CAMEL elements depictedhigher values, which meant healthier bank condition. This also ap-plied to the combine of those from the whole Central Java province.It could be concluded, therefore, that the merger of healthy BPRswith those that were healthy enough, and even less healthy or un-healthy produced a healthy bank. This indicated that there wereconsolidated operations and harmony between branches, so thatmerger created positive values that could benefit not only the share-holders but also all stakeholders.

From non-financial point of view, merger created new trust relationson the part of the community to enhance the bank development.From financial point of view, the bank would be making progress,because the new trust relations would increase the amount of fundsreceived from the community, which would automatically increasethe amount of credit distributed to the community to enhance in-vestment and community economic empowerment. Credit reservegrowth after merger proved to be higher compared with that beforemerger, or in other words, merger could promote the credit servicesrendered to the community. Making larger profit, the bank becamemore efficient and productive. Through merger, the increasing profitbrought positive impact on the deposit of genuine local income.Merger of BPR BKK Ungaran could promote trust relations with stake-holders and motivate the community to take part in the attempt topromote the bank condition, so that it could become better andhealthier.

Based on the above findings, it could be concluded that local bankmerger could promote bank development and condition, the quality

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Pengembangan Bank Lokal dengan Merger

of human resources, efficiency, effectiveness of control and also en-hance the people's economic empowerment, because the bank couldbecome healthier and strategic. In addition, local bank merger en-hanced the role of stakeholders and increased the community's trust.

Apart from the positive aspects of BPR BKK bank merger, severalnegative aspects or weaknesses were worth noting, namely (1) thelengthy process of decision making on capital deposit. As a local en-terprise, the decision on capital deposit had to await approval fromDPRD (Local Legislative Assembly) Level 1 as well as Level 2, (2) thepossibility of the Board of Directors' policy being dominant involv-ing personal interest, which would influence decision making, (3)the health level of the bank was measured based on consolidated data,so that good branches could be affected by poor branches, (4) accu-mulation of outstanding loans, since the combination of credit in ar-rears increased non-performing loans, (5) corporate tax obligation thatwould be higher when progressive tariff was applied, (6) the old im-age already attached to the institutions being merged could not beinstantly removed. The old impression of being manned by weakhuman resources still remained with the new institution.

Less satisfactory services, unstrategic location of the office, and un-comfortable office atmosphere were still attached to the new bank.

In consideration of the negative aspects above, it could be concludedthat the merging of BPR BKK local enterprises, BPR BKK Ungaran inparticular, did not instantly bring improvements to all aspects andremove the former inherent weaknesses. It took time for the newmanagement to do reorganization and take concrete steps to resolvethe problems. A number of merger-related weaknesses according toMahmud Z included, among others, with the organization becominglarger, managerial decision making took longer time, and the com-munication channel became longer.

Theoretical Implications

In brief, after the merger, BPR BKK Ungaran local enterprise becamemore able to create values not only from economic viewpoint in theform of larger profits due to the consolidation of 9 BPR BKK localenterprises joined together, healthier bank condition, and larger bankassets, but also enhance the competitive ability that could speed up

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the growth of BPR BKK Ungaran local enterprise. This was in linewith Healy (1992), who in his research found out that banks withlarger assets depicted a significant increase in the profits gained. Theoutcome of Sarwono's research (2007) on Bank Mandiri merger alsorevealed that merger proved to have increased profits and taxes ob-tained from the bank. A compilation of research by Weston, Mitchellet al (2004) indicated the impact of merger of the first category re-lated to the increased values of the merging business companies.Merger was an investment decision having long-term impact thatserved as development strategy. This was in line with Mahmud Z(2010), who found out that long-term objectives were attained bymeans of transforming banking enterprise limits.

Hence this research affirmed the theory that consolidation createdvalues in inter local bank merger. Increased values were observablein several performance indicators, such as the bank becoming healthierand more transparent. The bank established through merger thatbecame healthier with stakeholders' support, particularly evident inimproved community-bank trust relationship, could eventually servedto prove that BPR BKK local enterprise as a local bank was becomingmore competitive.

Policy Implications

The lengthy merger process duly completed, the attempt was worththe while. BPR BKK local enterprise depicted better performance.Regency and provincial government as shareholders became morerational and would be interested in BPR BKK local enterprises withbetter prospects. It was just natural if shareholders would be moreencouraged to increase their capital deposit in the hope to get divi-dends and larger amount of taxes. Moreover, they could be proud oftheir BPR BKK local enterprise, as it was able to empower the com-munity. In other words, the local government as shareholders wouldbe reluctant to increase their capital if the enterprise belonging tothem did not perform well. The best policy, therefore, was to im-prove the BPR BKK local enterprise by encouraging the managementteam (board of directors) to work more elegantly based on a betterincentive system.

BPR BKK local enterprise as a merger product proved to have beenable to increase their absolute capital, because of the accumulation of

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profits retained and more extensive services to reach the customer.The community, therefore, did not have to go far to find a largerbank, as in the vicinity, a quite large bank established through merger(BPR BKK local enterprise) was already available. A local bank grow-ing larger indicated the greater trust the community had in the bankconcerned. Hence, the policy implication was to strengthen the strat-egy of local bank growth as an attempt to empower the people's com-munity as envisaged in the original ideal of BPR BKK establishmentin 1970.

The merging of BPR BKK local enterprises, particularly that ofUngaran, though bringing about improvement in several aspects, couldnot instantly remove the previous negative aspects still attached tothe post merger BPR BKK local enterprises. It took time on the partof the management team to straighten out the organization and takeconcrete steps to resolve the problems leading to more professionalBPR BKK local enterprises with competitive ability at the regionallevel.

Further Research

In the process of BPR BKK local enterprise development through vari-ous kinds of turmoil and economic, social as well as political dynam-ics for more than 30 years since its establishment in the 1970s as anordinary finance constitution with no corporate body in the form ofBKK, BPR BKK local enterprises have now managed to prove theiridentity, committed to serve the lower layer of the community aswell as the micro, small and medium business enterprises, and able tocompete with other micro finance institutions as well as general banksthat thronged to get entrance to the micro finance market segment.The formulation of a corporate body and merging of local bankingenterprises suggested that BPR BKK local enterprises have adjustedthemselves to the existing regulations. Hence, regency and provin-cial government as shareholders could now have a better look at BPRBKK local enterprises as finance institutions growing in maturity andable to practice good corporate (banking) governance.

This study has enriched and given contribution to the institutionaldevelopment scheme, particularly improvement of the role of microfinance institutions through merger for the economic empowermentof the lower layer of the community and micro, small and medium

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business enterprises. The researcher, who is also a BPR BKK localenterprise executive, has in depth knowledge of BPR BKK local en-terprises and the community being served, but there is still room forfurther research, among others: (1) the element of community - BPRBKK local enterprise trust relations. The problem that ran be investi-gated further is whether BPR BKK local enterprises after getting largerin terms of capital strength and assets through merger are able tomaintain their customers so that they will not turn to another fi-nance institution. (2) It has been proven that after merging, BPR BKKlocal enterprises are in possession of high quality human resourcesresulting in better performance. However, in the course of their de-velopment, they still have to face a lot of challenges in renderingservices to the community as an intermediacy institution due tochanges in the surrounding environment pertaining to shareholders'demand, legislative-executive political relations, and tighter compe-tition. For this reason, a research problem that can be dealt with infurther research is related to the development of competitive abilityon the part of BPR BKK local enterprises in the micro finance seg-ment. (3) Competition among shareholders in depositing their capitaldeserves further investigation to find out whether or not sharehold-ers are being disinterested in the decision making process and inter-fere in the bank management. (4) Conflict of interest between civilservants and supervisors as shareholders is also worth examining.Supervisors as owners as well as employees will give different re-sponses and exercise different means of control, so that hypotheti-cally will also create different organizational performance. This do-main has not been much worked on in the local banking sector.

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